The effects of monetary policy in a small open economy: the case of Portugal

In this article, I analyse the macroeconomic effects of monetary policy on the Portuguese economy. I show that a positive interest rate shock leads to: (i) a contraction of real GDP and a substantial increase of the unemployment rate; (ii) a quick fall in the commodity price and a gradual decrease of the price level and (iii) a downward correction of the stock price index. It also produces a ‘short-lived liquidity effect’ and helps explain the negative comovement between bonds and stocks. In addition, I find evidence suggesting the existence of a money demand function characterized by small output and interest rate elasticities. By its turn, the central bank’s policy rule follows closely the dynamics of the money markets. Finally, both the real GDP and the price level in Portugal would have been higher during almost the entire sample period if there were no monetary policy surprises.     

INFLATION PERSISTENCE AND FLEXIBLE PRICES*

If the central bank follows an interest rate rule, then inflation is likely to be persistent, even when prices are fully flexible. Any shock, whether persistent or not, may lead to inflation persistence. In equilibrium, the dynamics of inflation are determined by the evolution of the spread between the real interest rate and the central bank's target. Inflation persistence can be characterized by a vector autocorrelation function relating inflation and output. This article shows that a flexible‐price, general‐equilibrium business cycle model with money and a central bank using an interest rate target can account for such inflation persistence.     

我国经济周期波动率的成分分解及稳定性研究

随着世界经济周期波动的减缓,我国经济波动也呈现出稳定性趋势.文章通过建立具有货币政策干预的产品市场均衡模型,对我国实际产出波动率进行了成分分解,并将实际产出波动的来源归结为需求冲击、供给冲击和货币冲击的作用.通过这些经济冲击方差序列的度量,又对实际产出波动率进行了冲击方差序列的回归检验,发现我国需求冲击和货币冲击强度的逐渐平稳是经济周期波动率降低的主要原因,而供给冲击对实际产出波动率没有产生显著影响.因此,我国宏观经济调控仍然需要坚持需求管理的政策导向,以保持经济持续稳定增长.     

DOES MONEY MATTER FOR INFLATION IN THE EURO AREA?

We analyze the relationship between M3 growth and inflation within an error correction framework including also the output gap, the 3‐mo EURIBOR, and the 10‐yr government bond yield. We find robust cointegration between money growth and inflation. Shocks in M3 growth account for up to 30% of the inflation forecast error variance, while the effects of output gap and interest rate shocks are mainly transitory. Significantly different dynamics are found during periods at the end of the seventies and beginning of the eighties when interest rate and inflation rate levels were high and real money growth decreasing. (JEL C32, E31, E41)     

中国房地产价格波动与宏观经济——基于SVAR模型的研究

房地产价格与宏观经济有着紧密的联系。本文利用1999年1季度至2009年2季度的居民消费价格指数、国内生产总值、货币供给与住宅价格指数的季度数据,应用结构向量自回归模型估计了供给冲击、需求冲击与货币政策冲击对中国房地产价格变动的动态影响以及房地产价格冲击对通货膨胀率、国内生产总值增长率与货币存量增长率变动的动态影响。结果显示正向的房地产价格冲击最终导致通货膨胀率和国内生产总值增长率上升到一个新的高度,使货币供给增长率下降到一个较低的水平;而正向的供给冲击、需求冲击与货币政策冲击最终均导致房地产价格增长率上升到一个新的高度。     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

Output gap measurement and the New Keynesian Phillips curve for China

The New Keynesian Phillips curve implies that the output gap, the deviation of the actual output from its natural level due to nominal rigidities, drives the dynamics of inflation relative to expected inflation and lagged inflation. This paper exploits the empirical success of the New Keynesian Phillips curve in explaining China's inflation dynamics with a new measure of the output gap. We estimate the output gap using the Bayesian multivariate Beveridge–Nelson decomposition method, based on a multivariate dynamic model featuring distinct interactions among inflation, money, and real output in China. The empirical results using quarterly data spanning 1979–2010 show that the new measure of the output gap outperforms the traditional measures in fitting the New Keynesian Phillips curve. This result provides useful insights for inflation dynamics and monetary policy analysis in China.     

Real estate and relative risk aversion with generalized recursive preferences

This paper investigates how real estate wealth affects the household’s attitude toward risk, and derives the closed-form expressions for risk aversion with generalized recursive preferences. We find three channels through which real estate wealth affects risk aversion, and these channels are absent in the traditional measure of relative risk aversion as in Arrow (1965) and Pratt (1964). First, illiquidity and fluctuations in real estate value increase consumption risk, thereby increasing risk aversion. Second, real estate as an asset provides a cushion for absorbing negative shocks to households, reducing risk aversion. Third, an increase in real estate prices lowers the profit of the firm that uses real estate as a factor of production, induces a decline in the real wage, and causes a rise in consumption risk. This channel increases risk aversion. We study how these channels as a whole determine relative risk aversion using a basic real business cycle model with generalized recursive preferences and compare the results with the case of expected utility preferences. Finally, we explore the implications of the firm’s and the household’s real estate holdings and illiquidity of real estate on the risk premiums for equity and real estate.     

Stochastic growth with short-run prediction of shocks

We study a variation of the one-sector stochastic optimal growth model with independent and identically distributed shocks where agents acquire information that enables them to accurately predict the next period??s productivity shock (but not shocks in later periods). Optimal policy depends on the forthcoming shock. A ??better?? predicted realization of the shock that increases both marginal and total product always increases next period??s optimal output. We derive conditions on the degree of relative risk aversion and the elasticity of marginal product under which optimal investment increases or decreases with a better shock. Under fairly regular restrictions, optimal outputs converge in distribution to a unique invariant distribution whose support is bounded away from zero. We derive explicit solutions to the optimal policy for three well-known families of production and utility functions and use these to show that volatility of output, sensitivity of output to shocks, and expected total investment may be higher or lower than in the standard model where no new information is acquired over time; the limiting steady state may also differ significantly from that in the standard model.     

US money supply and global business cycles: 1979–2009

This article investigates the effects of the US money supply shock on global business cycles by employing a global vector autoregressive model containing 26 economies over the period from 1979Q2 to 2009Q4. The US money supply is incorporated as an endogenous variable for the US and a global factor for other economies. When a positive US money supply shock hits the global economy, developed economies (such as the US, Euro area and the UK) will have neither real output decline nor inflation pressure, while China and some other developing countries are going to have a significant decline of real GDP. The international spillover of the liquidity effect exists. The global effects of quantitative easing are discussed as well.     

Is it my money or not? An experiment on risk aversion and the house-money effect

The house-money effect, understood as people’s tendency to be more daring with easily-gotten money, is a behavioral pattern that poses questions about the external validity of experiments in economics: to what extent do people behave in experiments like they would have in a real-life situation, given that they play with easily-gotten house money? We ran an economic experiment with 122 students to measure the house-money effect on their risk preferences. They received an amount of money with which they made risky decisions involving losses and gains; a randomly selected treatment group received the money 21 days in advance and a control group got it the day of the experiment. From a simple calculation we found that participants in the treatment group only spent on average approximately 35 % of their cash in advance. The data confirms the well documented results that men are more tolerant to risk than women, and that individuals in general are more risk tolerant towards losses than towards gains. With our preferred specification, we find a mean CRRA risk aversion coefficient of 0.34, with a standard deviation of 0.09. Furthermore, if subjects in the treatment group spent 35 % of the endowment their CRRA risk aversion coefficient is higher than that of the control group by approximately 0.3 standard deviations. We interpret this result as evidence of a small and indirect house money effect operating though the amount of the cash in advance that was actually spent. We conclude that the house money effect may play a small role in decisions under uncertainty, especially when involving losses. Our novel design, however, could be used for other domains of decision making both in the lab and for calibration of economic models used in micro and macroeconomics.     

Seasonal Cointegration and Long‐Run Neutrality of Money in the USA

Using the notion of seasonal cointegration and a monetarist model, this paper re‐examines the long‐run monetary neutrality hypothesis, based on the seasonally unadjusted quarterly data of the US over the period 1959Q1–2004Q4. The results indicate that money is cointegrated with price at all possible frequencies while real output is cointegrated with price only at an annual frequency. The cointegration between money and price at the zero frequency, and non‐cointegration between real output and money at all possible frequencies, suggests that money affects nominal but not real variables in the long run.     

Money illusion and the long-run Phillips curve in staggered wage-setting models

We consider the effect of money illusion – defined referring to Stevens' ratio estimation function – on the long-run Phillips curve in an otherwise standard New Keynesian model of sticky wages. We show that if households under-perceive real economic variables, negative money non-superneutralities will become more severe. On the contrary, if households over-perceive real variables, positive money non-superneutralities will arise. We also provide a welfare analysis of our results and we show that they are robust to the inclusion of varying capital into the model. Firms' (over-)under-perception of the real prices of production inputs (strengthens) weakens negative money non-superneutralities. In the Appendix, we investigate how money illusion affects the short-run effects of a monetary shock.     

The optimality of nominal contracts

Summary. This paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances. Received: March 29, 1996; revised version: February 25, 1997     

Stock prices and long-run demand for money: evidence from Malaysia

This paper investigates the money demand function for Malaysia in the 1971-1996 period using the multivariate cointegration and error correction model methodology. The results suggest that a stable long-run relationship exist between real M2, the interest rate differential, income and stock prices. Stock prices have a significant negative substitute effect on long-run as well as short-run broad-money demand (M2) and its omission can lead to serious misspecification in the money demand function. The analysis from the vector error correction model (VECM) and the Toda & Yamamoto (1995) causality tests find that money is endogenous and that there is at least a unidirectional relationship between stock prices and real M2. Stock prices Granger cause real M2 indirectly through income between interest rates and stock prices and stock prices and money stock. This paper comes to the conclusion that due to the endogeneity of money, M2 cannot be completely controlled by Malaysia's central bank. Therefore, in formulating future monetary policy, the response of money demand to stock prices should be considered.     

Relative wage concern: the missing piece in the contract multiplier?

Recent research has cast serious doubts on the explanatory power of staggered wage/price setting to account for both output and inflation persistence following money shocks. This paper extends a dynamic general equilibrium model with wage staggering by incorporating relative wage concern on the part of workers. In sharp contrast to previous analyses, in this model both output and inflation dynamics exhibit substantial persistence. Moreover, persistence results hold for a wide range of parameterisations. Our results suggest that relative wage concern may be the missing piece in the money shock persistence puzzle.     

Real Money Demand,Income, and Interest Rates in Senegal: Is there a Long-Run Stable Relation?

In this paper, I examine the stability of the long-run relationship between real money demand, income, and interest rates in Senegal. Using advances in unit root and co-integration, I test for co-integration between M1 velocity, output, and the interest rate. By virtue of the fixed exchange rate regime, I used both the three months French Treasury bill and the deposit rate to proxy the opportunity cost of holding money. I used Stock and Watson (1993) DOLS in addition to an ECM. Quarterly data ranging from 1970:Q4 to 2006:Q4 is used in the analysis, and the results reveal evidence of co-integration between real money demand, income, and the interest rate. For this study, I used both an ECM co-integration test and Johansen (Journal of Economic Dynamics and Control 12(2/3), 231-254, 1988) co-integration method.     

Real estate investment: Market volatility and optimal holding period under risk aversion

This paper deals with real estate portfolio optimization when investors are risk averse. In this framework, we examine an important decision making problem, namely the determination of the optimal time to sell a diversified real estate portfolio. The optimization problem corresponds to the maximization of a concave utility function defined on both the free cash flows and the terminal value of the portfolio. We determine several types of optimal times to sell and analyze their properties. We extend previous results, established for the quasi linear utility case, where investors are risk neutral. We consider four cases. In the first one, the investor knows the probability distribution of the real estate index. In the second one, the investor is perfectly informed about the real estate market dynamics. In the third case, the investor uses an intertemporal optimization approach which looks like an American option problem. Finally, the buy-and-hold strategy is considered. For these four cases, we analyze in particular how the solutions depend on the market volatility and we compare them with those of the quasi linear case. We show that the introduction of risk aversion allows to better account for the real estate market volatility. We also introduce the notion of compensating variation to better measure the impacts of both the risk aversion and the volatility.     

The effect of ambiguity aversion on reward scheme choice

We test the implications of ambiguity aversion in a principal–agent problem with multiple agents. Models of ambiguity aversion suggest that, under ambiguity, comparative compensation schemes may become more attractive than independent wage contracts. We test this by presenting agents with a choice between comparative reward schemes and independent contracts, which are designed such that under uncertainty about output distributions (that is, under ambiguity), ambiguity averse agents should typically prefer comparative reward schemes, independent of their degree of risk aversion. We indeed find that the share of agents who choose the comparative scheme is higher under ambiguity.     

BACKGROUND RISK AND THE THEORY OF THE COMPETITIVE FIRM UNDER UNCERTAINTY*

This paper examines the optimal production decision of a firm under output price risk á la Sandmo when the firm also faces a dependent background risk. It is shown that standard risk aversion plus a non-negative association between the output price risk and the background risk are sufficient to ensure a reduction in the firms optimal output upon introduction of the background risk. The paper investigates the impact of a deterministic transformation of the background risk on the firms optimal production decision. It is shown that decreasing absolute risk aversion in Ross' sense is among the sufficient conditions that generate an unambiguous negative comparative static result.